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Steve Allen of VAT Advisers Ltd looks at the reduced rate of VAT for certain types of building works relating to residential property.

Introduction

My, how time passes - 1 April 2011 will mark the 10th anniversary of the introduction of the 5% reduced rate of VAT for certain types of building works relating to residential property. The 5% rate was part of the Government’s 2001 ‘Urban Regeneration Scheme’, which encouraged redevelopment of brownfield sites rather than using Green Belt land.

Over the first few years, the 5% rate wasn’t used anywhere near as much as it could have been. Whether this was down to builders not knowing about the relief, or them simply choosing to keep life simple by charging standard-rated VAT regardless, we’ll probably never know. However, awareness did increase, and the use of the 5% rate has since proved very beneficial to developers and property investors, whether on a ‘buy-to-sell’ or ‘buy-to-let’ basis. Given the forthcoming anniversary, we thought it might be useful to give everyone a quick and basic reminder of how the relief works.

The Reliefs

There are two main types of 5% relief as follows:

1. Renovation of Empty Dwellings

Under this provision, where an existing residential property is renovated after being empty for at least two years, the renovation building services can be supplied to the property owner at the 5% rate. At the 2001 introduction, properties had to be empty for at least three years or more previously, but this was reduced to two years from 1 January 2008 to stimulate an even greater use of the relief.

2. ‘Change in Number of Dwellings’ Conversion

This applies where the number of dwellings in the property after the conversion changes from the number of dwellings present before the conversion. The use of the word ‘change’ means the number of dwellings can either increase or decrease, and includes changes from zero dwellings to one or more. The latter means that the conversion of a non-residential building into residential property (e.g., converting a restaurant into a house, or a warehouse into apartments) is eligible for the relief.

The Practical Benefits

Renovations

Buy-to-Let

As the letting of residential property is exempt, the VAT incurred on the costs of renovating the property is exempt and non-recoverable unless the property owner is VAT-registered, and is able to use the partial exemption ‘de minimis limits’ to reclaim all his exempt VAT (which we won’t go into here). Quite simply, by ensuring that the builder charges the 5% rate on the renovation services, the property owner will reduce his non-recoverable VAT by 12.5%.

Buy-to-Sell

Like the letting of residential property, the sale of an existing dwelling is also exempt, so the same 12.5% saving on renovation services is available to buy-to-sell investors by securing the 5% rate. In addition, a little-known VAT incentive (also introduced in 2001) allows for existing residential properties which have been empty for ten years or more, to be treated as ‘non-residential’, meaning that the onward sale after the renovation can be zero-rated instead of exempt. This allows the property owner the option of voluntarily registering for VAT and recovering all the 5% VAT incurred on the renovation costs (as well as the VAT incurred on other costs such as standard-rated professional fees). 

Conversions

Buy-to-Let

Let’s use the example of a developer buying a large house for conversion into flats for letting (and vice versa – flats back to a single house). Due to the change in the number of dwellings, the builder can charge the owner 5% VAT on the conversion services. As the lettings are exempt, the 5% VAT is non-recoverable, but still gives a 12.5% VAT saving similar to that available on renovations.

Buy-to-Sell

Using the above ‘house-into-flats’ example, the onward sales of the flats are also exempt, but there is again a 12.5% saving by reducing the non-recoverable VAT to just 5%. Also, similar to the 2001 zero-rate for the sale of existing dwellings empty for 10-years or more, the sale of a new dwelling after conversion from a non-residential building can be zero-rated (e.g., pub into flats).  This again allows the property owner to voluntarily VAT register and reclaim the 5% VAT (and other 17.5% VAT) on the conversion.

Other Issues

Certificates

Note that the certificate regime only applies to buildings intended for a ‘relevant residential purpose’ (e.g., a care home) or ‘relevant charitable purpose’ (e.g., a hospice). It does not apply to ‘dwellings’, so there is no requirement to give the builder a certificate in order to be able to apply the 5% rate.

[ Of course, with the standard rate of VAT set to increase in January 2011, a 5% rate for building services will look even more attractive - Ed. ]